Analysing the Effects of Third-Party Funds and Financial Ratios on Muḍārabah Financing

Purpose — This paper aims to investigate the relationship between financial indicators of Islamic banks in Indonesia and muḍārabah (profit sharing) financing. The financial indicators considered are third-party funds (TPF), capital adequacy ratio (CAR), non-performing financing (NPF), and net profit margin (NPM). Design/Methodology/Approach — This study adopts a quantitative approach, analysing the Islamic banks’ financial statements from 2014 to 2023. The research design utilises a non-random sampling technique instead of purposive sampling, which focuses on specific criteria. This means that the sample is deliberately selected by considering certain criteria, notably complete financial statements relevant to the study’s purpose. The data analysis technique used is data panel regression. Findings — The study reveals that muḍārabah financing is influenced by factors such as funds from external sources (TPF), a bank’s capital strength represented by CAR, and the level of NPF and NPM. Interestingly, the study found no impact from the existence of NPF itself. NPF is not found to be an influencing factor on muḍārabah financing because Islamic banks have increased their distribution of muḍārabah financing over the years to offset the impact of high NPF and to cover losses arising therefrom. Originality/Value — The research question focuses on how muḍārabah financing is affected by specific bank financial indicators. This combination of topics has not been extensively studied before, making it a unique and original research area, especially in the context of Indonesia. Research Limitations/Implications — The scope of this study is restricted to investigating how bank financial indicators affect muḍārabah financing. Although the research offers insightful information on the topic, it does not examine the impact of the financial indicators on other Islamic modes of financing or the larger financial environment. Second, it might be challenging to establish a direct causal relationship between muḍārabah financing and bank financial indicators as other variables may affect the connection, and correlation does not always indicate causality. Practical Implications — Examining the relationship between muḍārabah financing and specific bank financial indicators provides valuable insights for policymakers, regulators, and financial institutions. These insights can inform decision-making and contribute to the stability and efficiency of the Islamic banking system.